Post on 16-Feb-2016
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Valuation Training
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Table of Contents
1. What are we Valuing? 1
A. Valuing a Public Company 2
B. Valuing a Private Company 3
2. Valuation Methodologies 4
A. Comparable Companies 6
B. Precedent Transactions 9
C. Discounted Cash Flow 12
D. Leveraged Buy-out 19
1. What are we Valuing?
· When we value a firm we are essentially attempting to put a value on the equity and the debt injected into the company· Both debt and equity holders have a claim on the assets and the profits generated by those assets
– As mentioned above, the claim that debt holders have on the profits generated is usually already agreed (e.g. interest)– Equity holders are then entitled to the remaining profit of the company (net profit)
· Given that equity and debt holders are entitled to a proportion of profits, several of the methods that we use to value firms are based on the profit streams of companies and this is what we will focus on today – However depending on the industry you work in, different valuation methodologies exist some of which may not be based on profits
· Note that for publicly listed companies, market values already exist and enterprise value can be calculated from market data – However the methodologies discussed today are also used by analysts to determine whether a publicly listed company is over/
under-valued and what is a “fair value” for a company
What is a Firm and What are we Trying to Value? A business can have many components to its capital structure, all of which have some form of claim on the overall business. Firm value represents the aggregate value of all interests in a business.
Minority Interests
Pref. Shareholders
Common Shareholders
Creditors
Firm Value
· A firm is a group of assets (and associated liabilities) that is used to produce output through the transformation of inputs (e.g. labour, materials, property etc.) and in doing so generate profit for its owners
· Equity, put simply, is the money that is injected into the company by the owners of the company in return for shares
Firm Value is the collective value of all stake holdings (equity, debt, etc.) with claims on a valued asset (e.g. operating assets) or economic streams (e.g. revenue, EBITDA) generated by such assets.
· Debt is money which is borrowed from investors and financial institutions and has an agreed rate of return (e.g. interest) and repayment terms between the company and the lender
1 What are we Valuing?
A. Valuing a Public Company
The Composition of Enterprise ValueFor a public company, we are able to calculate firm value based on publicly available information.
Net Impact of Options = No. of Options x (Share Price – Avg. Exercise Price)
In-the-Money Convertible Securities Potential Shares from In-the-Money Convertibles x Share Price
Total Debt = Debt (LT, ST, Out-of-the-money Convertible) + Finance Leases
Market Capitalisation = Share Price x Number of Shares
Liquid Resources Cash + Marketable Securities
Market Value of JVs and Associates
Market Value of Minority Interests
+
+
+
–
–
+
Value of shares in the market
Value of shares potentially issued from options, net of cash received
Value of shares potentially issued from convertible securities (see later)
Bank loans, overdrafts, bonds, convertible debt as well as finance leases
Not only cash in the bank, but also securities held by the company readily saleable
Interests in companies partially owned but which the company does not have control (owns <50%)
Interests of third parties in subsidiaries under the company’s control (owns >50%)
Equity Value
Net Debt
2 Valuing a Public Company
B. Valuing a Private Company
Valuation MethodologiesThe most commonly used methodologies in our advice to clients are outlined below.
Multiples Based Valuation Cash Flow Based Valuation
Comps Based Valuation (Inc. Sum-of-the-Parts) Discounted Cash Flow Precedent Transactions Leveraged Buy Out A B C D
· Multiples-based technique with reference to relevant publicly-traded market prices
· Based on relative valuations of public companies that are most comparable to our target
· Valuation multiples of such companies are applied to earnings metrics of our target company (e.g. sales, EBITDA) to derive valuation
· Multiples-based technique with reference to relevant completed M&A transactions
· Similar to comps based valuation
· Multiples are applied to earnings metrics – sales, EBITDA
· Most common methodology to estimate the fundamental of “intrinsic” value
· Valuation is based on cash flows attributable to the firm, irrespective of capital structure
· Value equal to the sum of the present values of such cash flows
· Discounted Cash Flow valuations are founded on the premise that company value is equal to the value of future cash flows generated by the company and available to be paid out to investors, discounted at the required rate of return demanded by investors
· Valuation based on the maximum amount a potential private equity investor can afford to pay for the business to achieve a target return
3 Valuing a Private Company
2. Valuation Methodologies
Summary Financial Data – Company A
Fiscal Year Ending 31 December
£ Million, Unless Otherwise Stated 2013A 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E
P&L
Sales 1,000.0 1,082.0 1,157.7 1,221.4 1,270.3 1,317.3 1,356.8 1,390.7 1,418.5 1,446.9 1,475.8 1,505.3
Growth 8.2% 7.0% 5.5% 4.0% 3.7% 3.0% 2.5% 2.0% 2.0% 2.0% 2.0%
EBITDA 130.0 162.3 196.8 224.7 241.4 256.9 271.4 278.1 283.7 289.4 295.2 301.1
Growth 24.8% 21.3% 14.2% 7.4% 6.4% 5.6% 2.5% 2.0% 2.0% 2.0% 2.0%
Margin 13.0% 15.0% 17.0% 18.4% 19.0% 19.5% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%
Depreciation (50.0) (54.1) (60.2) (64.7) (68.6) (72.4) (74.6) (76.5) (78.0) (79.6) (81.2) (82.8)
% Sales 5.0% 5.0% 5.2% 5.3% 5.4% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%
EBIT 80.0 108.2 136.6 160.0 172.8 184.4 196.7 201.7 205.7 209.8 214.0 218.3
Growth 35.3% 26.3% 17.1% 8.0% 6.7% 6.7% 2.5% 2.0% 2.0% 2.0% 2.0%
Margin 8.0% 10.0% 11.8% 13.1% 13.6% 14.0% 14.5% 14.5% 14.5% 14.5% 14.5% 14.5%
Cash Flow
CapEx (67.5) (68.7) (69.8) (71.2) (73.4) (76.1) (76.1) (76.5) (78.0) (79.6) (81.2) (82.8)
% Sales 6.8% 6.4% 6.0% 5.8% 5.8% 5.8% 5.6% 5.5% 5.5% 5.5% 5.5% 5.5%
CapEx/Depreciation 135.0% 127.0% 116.0% 110.0% 107.0% 105.0% 102.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Net Working Capital (50.0) (54.1) (57.9) (61.1) (63.5) (65.9) (67.8) (69.5) (70.9) (72.3) (73.8) (75.3)
% Sales (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)% (5.0)%
Change in Working Capital 4.1 3.8 3.2 2.4 2.4 2.0 1.7 1.4 1.4 1.4 1.5
Our analysis will be based on the following dummy company, Company A.
Company A
4 Valuation Methodologies
1,160
1,392
1,696
2,035
1,200
1,799
1,600
1,781
2,138
1,889
2,267
2,419
2,332
1,862
500 1,000 1,500 2,000 2,500 3,000
Comparables
Comparables – 20% Premium
SOTP
SOTP – 20% Premium
Precedents
DCF
Simple LBO
Valuation SummaryBased on various valuation methodologies, we have arrived at the following range of values for Company A.
Company A
1
2
3
4
5
6
7
5 Valuation Methodologies
A. Comparable Companies
Comps Based Valuation (Inc. Sum-of-the-Parts)
· Based on relative valuations of public companies that are most comparable to our target
· Valuation multiples of such companies are applied to earnings metrics of our target company, e.g. sales, EBITDA to derive valuation
· Compare and benchmark company on both qualitative and quantitative metrics. Examples of such metrics include – Sales and EBITDA growth – EBITDA margin and future margin uplift – Geographic Diversification – Quality of Brand and international potential – Stage in company lifecycle, etc.
· Decide whether company should be placed on a valuation multiple at a discount or a premium to the different comps given the metrics analysed above and value it at a suitable multiple
· Using this analysis we can also look at whether current publicly listed companies are undervalued or overvalued compared to its peer group
The Concept of MultiplesThe principal of comps based valuation is based on comparing our target company to publicly listed companies to derive a “fair” valuation.
6 Comparable Companies
Comparable Companies Analysis
Calculating Comp-based ValuationsBased on our comparable companies analysis, Target Company A is valued between £1,160m and £1,781m on a trading basis and between £1,392m and £2,138m on a take-out basis.
Company A
EV / Sales EV / EBITDA
CompanyShare
Price (p)Market
Cap (£m)Enterprise Value (£m) 2014 2015 2016 2014 2015 2016
2014–2016 Sales CAGR
2014–2016 EBITDA CAGR
2014 EBITDAMargin
Company B 375 5,025 6,556 2.1x 1.9x 1.8x 10.5x 8.6x 8.2x 8.0% 13.3% 22.0%
Company C 1,052 768 968 1.3x 1.2x 1.2x 9.3x 7.3x 7.3x 5.4% 12.7% 17.0%
Company D 786 3,276 3,576 1.6x 1.5x 1.5x 8.9x 7.7x 7.6x 5.0% 7.9% 19.4%
Company E 105 1,074 1,199 1.1x 1.1x 1.0x 9.2x 8.9x 8.3x 4.9% 4.9% 11.8%
Company F 832 202 252 1.5x 1.3x 1.2x 14.5x 9.3x 9.2x 9.9% 25.3% 14.0%
High 5,025 6,556 2.1x 1.9x 1.8x 14.5x 9.3x 9.2x 9.9% 25.3% 22.0%
Mean 2,069 2,510 1.5x 1.4x 1.3x 10.5x 8.4x 8.1x 6.7% 12.8% 16.8%
Median 1,074 1,199 1.5x 1.3x 1.2x 9.3x 8.6x 8.2x 5.4% 12.7% 17.0%
Low 202 252 1.1x 1.1x 1.0x 8.9x 7.3x 7.3x 4.9% 4.9% 11.8%
Indicative Valuation – Company A£ in Millions
Multiple Value
Low High Low High
2015E Sales £1,082 1.1x 1.9x £1,136 £2,056
2015E EBITDA £162 7.3x 9.3x £1,184 £1,507
Implied EV £1,160 £1,781
Implied 2014E EBITDA Multiple 7.1x 11.0x
Take-out Premium 20%
Implied EV (Inc. Premium) £1,392 £2,138
Implied 2014E EBITDA Multiple 8.6x 13.2x
1
2
Takeout Multiples and Control Premia· However, when public companies are acquired, a premium is
usually paid to the current share price to persuade shareholders to cede control of the company to the acquiror – This is known as the control premium and varies from market
to market · Valuations including a premium are known as “takeout valuations”
7 Comparable Companies
Sum-of-the-PartsIf a company is comprised of several separate distinct parts, we may value it based on fair valuations for each part of the business.
Company A
EBITDA Multiple Valuation
Company A 2015E EBITDA Low High Low High
Beer £62.8 9.5x 10.5x £596.7 £659.5Juice 11.0 8.0 9.2 88.3 101.5Soft Drinks 44.0 12.0 13.5 527.8 593.8Wine 23.7 9.0 10.2 213.3 241.7Spirits 20.8 13.0 14.1 270.1 292.9Group Total £162.3 10.5x 11.6x £1,696 £1,889Take-out Premium 20%Take-out SOTP Value 12.5x 14.0x £2,035 £2,267
3
4
Comps Based Valuation (Inc. Sum-of-the-Parts)
· Several companies can be split into separate and distinct operating assets
– Companies can be split into parts by operation or by geography for example
· Each part can therefore be valued individually to come up with a sum-of-the-parts valuation
· Whilst each part can be valued in various ways, we commonly use a range of valuation multiples for each part to derive a fair value for the company
– With public companies, this sum-of-the-parts valuation can then be used to see whether the company is currently over or undervalued at the current share price and whether there is value to be “released” from breaking up the company
Implied Multiple
8 Comparable Companies
B. Precedent Transactions
Precedent Transaction
· Similar to comps based valuation, multiples are applied to earnings metrics based on analysis of historical transactions
· Principles of precedent transactions are very similar to comparable companies analysis, although there are a few key differences which need to be highlighted
· Transaction multiples are generally historic (last twelve months or LTM) to the extent possible and not forward-looking like comps
· Transaction multiples will generally include a control premium and so the value derived is a take-out multiple rather than a trading multiple
· Comps use current market data and as such are based on current investor sentiment on a particular sector. However, since transactions are historic, the market may have evolved significantly since then and the multiple may not be relevant any more
· There may be factors that are particular to a relevant transaction e.g. structure that may have had an impact on valuation
Principles of Precedent TransactionsThe principles of precedent transaction analysis are very similar to comparable companies analysis, although thereare some key differences.
9 Precedent Transactions
Example Calculation· Company B acquires 75% of Target 1 for an equity value of £750m· Company B has net debt outstanding of £250m· Target 1 reported 2013 Sales and EBITDA of £900m and £120m and recently
reported 3Q14 Sales and EBITDA of £750m and £105m for the first nine months ended 31 September 2011. In 3Q10 it reported Sales and EBITDA of £650m and £100m respectively for first nine months ended 31 September 2013
Calculating Precedents· When calculating precedent transactions, we need to calculate the implied EV as
well as the most recent LTM metric (e.g. Sales, EBITDA, EBIT)
· Note however that on several occasions, not enough data will be in the public domain to calculate a multiple
· The calculation of EV is as presented previously, however, there are some key points to take into consideration when analysing precedent transactions:– Is the transaction value stated the amount paid for equity or the total
company?– In several cases, the acquiror does not purchase 100% of the company and as
a result the equity value stated needs to be grossed up to 100% to calculate the correct value
– Does the value stated include the net value of options?
· When calculating LTM metrics, we will use the last reported numbers, taking into account the last interim results the company has released– LTM EBITDA = Last Reported Full Year EBITDA + Last Reported Interim
EBITDA – Prior Year Interim EBITDA– Note that if the last reported numbers are the full year results, we do not need
to make any adjustment for interims
Calculating Precedent TransactionsWhen calculating enterprise value in precedent transactions, you need to make sure you are calculating a value for100% of the company.
Price Paid (£m) 750
Percent Acquired 75.00%
Implied Equity Value 1,000
Net Debt 250
Implied EV 1,250
FY13 Sales 900
Plus: 3Q14 Sales (L9M) 750
Less: 3Q13 Sales (L9M) (650)
LTM Sales 1,000
Implied EV / LTM Sales 1.3x
FY13 EBITDA 120
Plus: 3Q14 EBITDA (L9M) 105
Less: 3Q13 EBITDA (L9M) (100)
LTM EBITDA 125
Implied EV / LTM EBITDA 10.0x
10 Precedent Transactions
Calculating Precedent-Based ValuationsWhen choosing valuing companies based on precedent transactions, whilst qualitative and quantitative comparisonsshould be made, you will also need to look at details around the transaction to determine the correct multiple.
Precedent Transactions
EV / LTM
Date Announced Target Acquiror Transaction Value (£m) Sales EBITDA EBIT
5 June 2014 Target 1 Company C 1,250 1.3x 10.0x 16.3x
2 January 2014 Target 2 Company C 230 3.0x 12.3x 25.4x
26 May 2013 Target 3 Company A 500 1.1x 12.6x 14.4x
1 April 2013 Target 4 Company B 150 3.1x 13.4x 19.1x
21 February 2013 Target 5 Company D 2,000 2.0x 13.0x NA
High 2,000 3.1x 13.4x 25.4x
Mean 826 2.1x 12.2x 18.8x
Median 500 2.0x 12.6x 17.7x
Low 150 1.1x 10.0x 14.4x
Choosing Multiples· When choosing what multiple to apply to an LTM earnings figure, there may be
some precedent transactions which are more relevant than others– Here for example, only transactions 1–5 are relevant from all available
precedent transactions· As with comps, quantitative and qualitative comparisons between companies is
forms the basis of your judgement· However, there are other factors that may need to be accounted for which are
transaction specific such as– Was the acquisition, an acquisition of a minority stake?– Did the acquiror already own a stake in the target?– What was the strategic rationale behind the transaction?
Precedent Transactions
EV / EBITDA Value
Low High Low High
LTM Sales £1,000 1.1x 3.1x £1,100 £3,100
LTM EBITDA £130 10.0x 13.4x £1,300 £1,737
Implied EV £1,200 £2,419
Implied LTM EBITDA Multiple 9.2x 18.6x
5
Company A
11 Precedent Transactions
C. Discounted Cash Flow
Discounted Cash Flow – Key Building BlocksWith a DCF valuation, we are attempting to put a value on the future operating cash flows of the company that areavailable to be paid out to both equity and debt investors.
1. FCF for 10 Years 2. WACC 3. Terminal Value 4. NPV
Free Cash Flow
EBITDA
CapEx
Change in WC (Rec –Pay + Inv)
Tax on Operating Profit
WACC =
E/(E+D)*Cost of Equity +
D/(E+D)*Cost of Debt
Cost of Equity =
Rf + beta*(EMRP)
Cost of debt = (Rf + Credit differential)
*(1-t)
Proportion of Debt and Equity
Apply a multiple to the Terminal EBITDA
Net Present Value
FC1*(1+WACC)-1
+ FC2*(1+WACC)-2
+ FC2*(1+WACC)-3
+ .... +
(FC10+TV)*(1+WACC)-10
FCFTx(1+g)
K – g=
–
–
–
=
Using DCF Method
Using Multiple Method
12 Discounted Cash Flow
The amount of cash that a company has left over after it has paid all of its expenses, but before any payments or receipts of interest or dividends, before any payments to or from providers of capital and adjusting tax paid to what it would have been if the company had no cash or debt
Calculating the FCF
A Basic Definition of Free Cash Flow is
Sales X
Operating Costs (X)
EBIT X
Depreciation X
Amortisation X
EBITDA X
Changes in Working Capital X/(X)
Operating Cash Flow X
Tax Paid (X)
CapEx (X)
FCF before Interest X/(X)
Interest Paid (X)
Free Cash Flow X/(X)
13 Discounted Cash Flow
Calculating the WACC
· After calculating the required rates of return for both debt and equity investors, we then weight these required returns according to a target capital structure for the company, to come to an overall cost of capital for the company
The WACC for a company is calculated from a specific formula. Citi have issued guidelines for estimating the correctparameters for this calculation.
Weighted Average Cost of Capital (WACC) =Cost of Equity x (Equity/(Debt + Equity)) + Cost of Debt x (Debt/(Debt + Equity)) x (1 – Tax Rate)
WACC Calculation – Company A· The Cost of Equity is based on the CAPM and the following formula
where KE is the cost of equity Rf is the risk free rate and (Rm – Rf) is known as the equity market risk premium
· The EMRP is estimated by Citi to be between 5–7%
· Relevant government bonds are used for the risk free rate
· The Beta is calculated by taking an average of asset betas of comparable public companies
· Tax rate is usually the company specific tax rate
· Industry average is usually used for debt/capitalisation unless a specific target is known for the company
KE = Rf + β(Rm – Rf)
WACC Analysis
Low High
Cost of Equity 3.8% 3.8%
Risk Free Rate (30 Year) 3.8% 3.8%
Equity Market Risk Premium 5.0% 7.0%
Equity Beta 1.07 1.07
Adjusted Equity Market Risk Premium 5.4% 7.5%
Sovereign Risk Premium 0.0% 0.0%
Inflation Differential 0.0% 0.0%
Small Cap Premium 0.0% 0.0%
Cost of Equity 9.1% 11.3%
Cost of Debt
Risk Free Rate (10 Year) 3.8% 3.8%
Credit Spread 1.0% 2.0%
Inflation Differential 0.0% 0.0%
Cost of Debt (Pretax) 4.8% 5.8%
Effective Marginal Tax Rate 30.0% 30.0%
Cost of Debt (Aftertax) 3.4% 4.1%
Debt/Capitalisation (Market) 30.0% 30.0%
WACC 7.4% 9.1%
14 Discounted Cash Flow
· Once we have derived an overall required rate of return for the company, the cost of capital, we are able to value the value of the cash flows generated by the company in terms of how much it is worth today, the Present Value– The value of £1 tomorrow is worth less than the value of £1 today
· Say an investor has £100 to invest today and his required rate of return is 10%– In 1 year, he will want to receive 10% of £100 = £10 in addition to the £100. Therefore, to the investor, receiving £110
in one year is equivalent to receiving £100 today, i.e. £110/1.1 = £100– In 2 years, he will want to receive 10% of £100 and 10% of £110 in addition to the original
£100 = £100 x 1.1 x 1.1 = £121– In 3 years… etc.
· We use this concept therefore to derive the following formula for the present value of future cash flows which fall at the end of the year in every year from now
Where CF is the cash flow in its respective year and K is the required rate of return (the WACC)
The Concept of Present ValueWhen deriving a value for a company’s cash flows, we need to take into account the future timing of the cash flows in the forecast period.
PVCF1 CF2 CF3 CF4
(1+K)1 (1+K)2 (1+K)4(1+K)3= + + + + …
15 Discounted Cash Flow
· Cash flows for a company are continuous and do not fall to the investor at the end of the year in every year as the formula in the previous slide suggests
· We generally therefore use a mid-year convention, where we assume for valuation purposes that the cash flows that are generated in every year fall in the middle of the year and we value them on that basis
· In order to do this, we need to divide the formula in the previous slide by (1+K)0.5 to essentially shift cash flows back by half a year
· As a result the formula on the previous slide changes to as follows
Mid-year Cash Flow ConventionA company’s cash flows are continuous and we need to account for this in valuing cash flows over the forecast period by using the mid-year convention.
16 Discounted Cash Flow
PVCF1 CF2 CF3 CF4
(1+K)0.5 (1+K)1.5 (1+K)3.5(1+K)2.5= + + + + …
· Whilst we have discussed valuing cash flows over a discrete period of time (e.g. 10 years), we also have to value the cash flows of the company post the forecast period into perpetuity
· The value of the cash flows into perpetuity is known as the Terminal Value and can be calculated in one of two ways– Applying an multiple to a profit metric (e.g. EBITDA) in the final year (Comps Method)– Consider the “steady state” of the company and value its future cash flows based on an assumption as to the average long term growth
rate of the cash flows into perpetuity (DCF Method)· Both methods can be used as a cross check against each other to see if the result is sensible· However note that the value derived is the value of the cash flows into perpetuity at the end of the forecast period (e.g. in 10 years time if
the forecast period is 10 years long) and therefore needs to be discounted back to present value– However, note that we do not use the mid-year convention for discounting back
Terminal ValueThe terminal value of a company is the future value of the cash flows of the company after the forecast period and into perpetuity.
DCF Method· For this, there are two steps to be taken
– Calculate adjusted terminal year CF accounting for any exceptional items and equalising CapEx and depreciation· In the long term CapEx = depreciation and so if CapEx is
higher than depreciation we need to add the difference to the final year FCF and conversely if lower
– Assume a perpetuity growth rate (g)· The FV of the terminal value is then derived from the
following formula
Comps Method· The approach used here is the same as in our comps
based valuation focusing on average trading multiples of comparable companies
· You can use any profit metric you see suitable, although EBITDA most commonly used
· Note that the metric used should be excluding any exceptional items
· Assuming a 9.0x EBITDA multiple we derive a terminal value (future value) of £301m x 9 = £2,710m
FCFT x (1+g)
(K – g)
17 Discounted Cash Flow
Discounted Cash Flow ModelYear Ending 31 December
£ in Millions 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024Sales 1,082 1,158 1,221 1,270 1,317 1,357 1,391 1,419 1,447 1,476 1,505EBITDA 162 197 225 241 257 271 278 284 289 295 301Depreciation (54) (60) (65) (69) (72) (75) (76) (78) (80) (81) (83)EBITA 108 137 160 173 184 197 202 206 210 214 218Taxes (41) (48) (52) (55) (59) (60) (62) (63) (64) (65)Taxed EBITA 96 112 121 129 138 141 144 147 150 153CapEx (70) (71) (73) (76) (76) (76) (78) (80) (81) (83)Deprecation 60 65 69 72 75 76 78 80 81 83(Increase)/Decrease in WC 4 3 2 2 2 2 1 1 1 1Other 0 0 0 0 0 0 0 0 0 0Unlevered FCF 90 109 119 128 138 143 145 148 151 154Time Period 0.5 1.5 2.5 3.5 4.5 5.5 6.5 7.5 8.5 9.5WACC 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3%Discount Factor 0.96 0.89 0.82 0.76 0.7 0.65 0.6 0.55 0.51 0.47PV of FCF 86 97 97 97 97 92 87 82 77 73PV of Forecast Cash Flows 884
Terminal EBITDA
Final YearFCF
Using Comps Method Using DCF Method
Terminal EBITDA 301EBITDA Multiple 9.0xFV of Terminal Value 2,710Discount Factor 0.45PV of Terminal Value 1,226
Implied Enterprise Value 2,111
Final Year Cash Flow 154Perpetuity Growth Rate 2.0%Terminal FCF 157WACC 8.3%FV of Terminal Value 2,518Discount Factor 0.45PV of Terminal Value 1,139Implied Enterprise Value 2,024
EBITDA Multiple
8.5x 9.0x 9.5x
WACC
7.8% 2,117 2,189 2,260
8.3% 2,043 2,111 2,179
8.8% 1,971 2,036 2,101
Property Growth Rate
1.5x 2.0x 2.5x
WACC
7.8% 2,092 2,202 2,332
8.3% 1,934 2,024 2,129
8.8% 1,799 1,873 1,9596
6
Company A
18 Discounted Cash Flow
D. Leveraged Buy-out
· In a leveraged buyout the principle is as follows– A company is acquired for a given price through a combination of debt funding (usually between 50–70% of total funding) and equity
from the private equity firm– Over the next few years, the company increases its profitability and also uses its cash generated to pay down the debt that the PE firm
has used to acquire the business– In the medium term, usually 3–5 years, the company is sold, based on a higher EBITDA with the proceeds being used to pay back debt
(which is now lower than when the company was acquired originally) and the difference in the exit price and the level of debt goes to the private equity player
· The private equity player generates returns from selling its equity in the business for a substantially higher price and as such, we can derive a maximum price payable today for the company by setting a level of target returns for the private equity player
Principles of an LBOGiven the increase in M&A activity by private equity players, working out how much they can potentially pay to generate a required return has become a key driver of valuation.
On Acquisition 2013 2014 215 On Exit
Debt Equity
19 Leveraged Buy-out
· We have acquisition of the target for £1,500m financed through £900m of funded debt and £600m equity
· Every year the company generates cash and by 2018, the net debt of the company is only at c.£600m
· We have assumed an exit at 9.0x EBITDA in 2018 valuing the company at c.£2,300m on exit– Given implied net debt of c.£600m in 2018, this implies an equity value of c.
£1,700m on exit· The internal rate of return (IRR) is the return made on the investment and is the
same in principle to the discount rate– The IRR is the rate of return on the investment where the present value of
the future cash flows to the equity investor at that rate is equal to the initial value of equity used to buy the business
· The IRR in this case is 29.8%, i.e. £1,705m discount back 4 years at a rate of 20.0% gives us a value of £822m
· Therefore based on a value on exit, we are able to calculate the maximum price payable by a firm today to generate a given return
Example LBO ModelGenerally speaking, a private equity player will look to generate returns in excess of 20%, although this will vary from sector to sector.
Max Price Calculation – Company A
Company A
EBITDA 257Exit Multiple 9.0xExit Value 2,312Less: Net Debt (607)Implied Equity Value 1,705EV on Acquisition 1,500Less: Net Debt on Acquisition (900)Equity Value on Acquisition 600Cash on Cash Return 2.8xImplied IRR 29.8%
Cash Flow Statement – Company A£ of Million 2015 2016 2017 2018EBIT 137 160 173 184
Depreciation (60) (65) (69) (72)EBITDA 197 225 241 257Change in WC 4 3 2 2Net Interest (61) (57) (52) (46)Tax (23) (31) (36) (42)Capex (70) (71) (73) (76)Change in Net Debt 47 69 82 96Starting Net Debt 900 853 785 702Closing Net Debt 853 785 702 607
Exit Valuation – Company AEBITDA 257Exit Multiple 9.0xExit Value 2,312Less: Net Debt (607)Equity Value 1,705Target IRR 20.00%Discount Factor 0.48Implied Current Value of Equity 822Plus: Net Debt on Acquisition 900Implied Acquisition Value 1,722
Target IRR
15.0% 17.5% 20.0% 22.5% 25.0%
Exit Multiple
8.0x 1,728 1,660 1,598 1,543 1,493
8.5x 1,801 1,727 1,660 1,600 1,546
9.0x 1,875 1,795 1,722 1,657 1,598
9.5x 1,948 1,862 1,784 1,714 1,651
10.0x 2,022 1,929 1,846 1,771 1,7047
7
20 Leveraged Buy-out
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